Should You Buy the Second-Highest Yielding Vanguard S&P 500 Sector ETF?

The stock market is made up of 11 sectors. In order of market cap, they are information technology, financials, healthcare, consumer discretionary, communication services, industrials, consumer staples, energy, utilities, materials, and real estate.

With a yield of 3.3%, utilities is the second-highest yielding sector behind real estate and just ahead of energy.

Here’s a simple yet effective exchange-traded fund (ETF) to gain exposure to the sector, why utilities could benefit from artificial intelligence (AI), and why the sector stands out as an excellent value.

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Keep it simple with the Vanguard Utilities ETF

The Vanguard Utilities ETF (VPU 0.06%) is a low-cost way to invest in the sector. It consists of 66 holdings, with 62.5% of the fund in electric utilities.

NextEra Energy, Southern Company, Duke Energy, Constellation Energy, Sempra, and American Electric Power make up a combined 40.5% of the fund — with the other 60 holdings all sporting weights of 4% or less.

Due to its low-growth nature, the utility sector tends to trade at a discount to the market. Sure enough, the Vanguard Utilities ETF has a 21.8 price-to-earnings ratio compared to 27.9 for the Vanguard S&P 500 ETF.

The fund charges a mere 0.1% expense ratio, or $10 for every $10,000 invested. There’s really no better way to invest in several different companies at once — which can be an advantage in the sector since utilities tend to specialize in a particular industry within a specific geography.

For example, Southern Company dominates Alabama, Georgia, and Mississippi. It has power-producing assets around the country, but its bread and butter is the Southeastern U.S. Buying the Vanguard Utilities ETF ensures that you get exposure to the sector and don’t over concentrate in one region.

AI and the utility sector

Semiconductor companies like Nvidia (NASDAQ: NVDA) and Broadcom have taken center stage in the AI rally. There are also companies that are large customers of the chipmakers — such as Meta Platforms, which uses AI across its applications to improve customer engagement and attract advertisers.

However, the issue with many of these stocks is they have gotten more expensive as investors value them based on what their earnings could be years from now rather than where they are today.

A different approach is to look at the industries that benefit from increased AI adoption. For example, Vertiv makes thermal management solutions that help cool down server racks — which could see growing demand as more data centers are built. Pipeline and energy infrastructure companies like Kinder Morgan help connect natural gas production regions to areas of consumption. More data centers means higher electricity consumption — and the reliability of natural gas and nuclear energy could be key ways to add stability to the electric grid.

Utilities produce power from fossil fuels and renewable energy, which means they care more about increased energy use than the source of energy. Many of the largest integrated utilities produce power and have transmission networks to transport that power. They play a pivotal role in hooking up data centers to the grid or forming an independent microgrid.

Data centers that emphasize stability may turn to utilities with nuclear and natural gas assets, while those that seek sustainability may want to focus on renewable energy or access the credit market to offset emissions.

A balanced way to invest in multiple trends

Utilities are a value-orientated way to invest in growing AI adoption. The gradual increase in demand for resources like electricity, natural gas, and water should help boost cash flows and support new infrastructure investment.

The investment proposition for utilities is straightforward as well. Many top utilities pass along the majority of profits to shareholders through stable and growing dividends. The key is to earn enough money to manage existing expenses, fund and operate new projects, and distribute payouts to shareholders. Regulated utilities work with government agencies to set prices, which can limit growth but also add a layer of predictability to cash flows.

It’s a far different business model than, say, GE Vernova — which makes a variety of products and systems to provide power and backup power to data centers. Or Nvidia’s graphics processing units, which are a primary energy consumer across data centers.

Utilities don’t have nearly as much growth potential as these companies, but they are also far from just a pure AI play.

Utilities are one of the least cyclical sectors in the market. Sure, resource demand can rise from a growing economy. But residential demand for electricity is fairly constant no matter what the economy is doing. This quality makes utilities a safe haven for risk-averse investors.

A passive income power play

The utility sector could benefit from AI adoption, but that’s just one of many catalysts driving increased energy demand. The biggest multi-decade tailwinds for the utility sector are a growing population and the need for a cleaner and more reliable grid.

Some utilities could be better buys than others. But if you’re new to the sector, the Vanguard Utility ETF is a great way to unlock broad-based exposure and charge your portfolio with a jolt of passive income.

Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Constellation Energy, Kinder Morgan, Meta Platforms, NextEra Energy, Nvidia, and Vanguard S&P 500 ETF. The Motley Fool recommends Broadcom and Duke Energy. The Motley Fool has a disclosure policy.